Treasury move inhibits loans at low interest

The Treasury plans to increase what is known as the official interest rate to a level closer to the prime lending rate, the Budget Review notes.

At present the official interest rate is 7.75% — the Reserve Bank’s repurchase (repo) rate (currently 6.75%) plus one percentage point. The prime rate is 10.25%.

Julia Moore, of Bowmans’ tax practice, says an increase in the official rate of interest will discourage low-interest loans from employers, and significantly increase tax on loans made to trusts.

Donors typically sell assets to a trust, and the trust, to pay for them, borrows from the donor at no interest or a low rate and writes off the loan with donations below the exemption each year.

But since March 2017, such a loan triggers a deemed donation equal to the difference between the actual interest and the official interest rate. This donation attracts 20% tax.

The Treasury says it will propose increasing the official rate in this year’s tax law amendments to bring it in line with rates at commercial banks and because interest rates lower than prime are rare.

Moore says it does not make sense for loans made to trusts to be linked to prime rate. It would be more relevant to consider the investment return one could earn.